Of Interest

Monday, April 28, 2014

Suspicion grows that China is exporting deflation worldwide by driving down yuan

The
Chinese Yuan weakened yet again this morning, punching through the key
line of 6.25 against the dollar. It is almost back to where it was two
years ago. This is the biggest story in the global currency markets.

Yuan
devaluation has reached 3.1pc this year. The longer this goes on, the
harder it is to accept Beijing’s story that it is one-off measure to
teach speculators a lesson and curb hot money inflows.

The
US Treasury clearly suspects that the Chinese authorities have reverted
to their mercantilist tricks, driving down the exchange rate to keep
struggling exporters afloat. Officials briefed journalists in Washington
two weeks ago in very belligerent language.

The
Treasury’s currency report this month accused China of trying to
“impede” the market by boosting foreign reserves by $510bn last year to
$3.8 trillion — “excessive by any measure”.

It
gave a strong hint that China is disguising its reserve accumulation.
You don’t have to dig hard. Simon Derrick from BNY Mellon said a recent
buying spree of US Treasuries and agency debt by Belgium of all places
looks like a Chinese front.

Holdings by
entities in Belgium have jumped to $341bn from $169bn last August. This
would appear to explain how China’s FX reserves have kept rising to
$3.95 trillion even as its custody holdings in the US itself have been
falling. If so, China is playing dirty pool.

Hans
Redeker from Morgan Stanley says China seems to have adopted a “beggar
thy neighbour policy” to counter the slowdown at home and soak up excess
manufacturing capacity.

Albert
Edwards from Societe Generale said in a note today that China is
“sliding inexorably towards deflation”. Factory gate prices have been
falling for 25 months in a row.

The GDP
deflator — which proved a much better gauge of trouble at the onset of
Japan’s Lost Decade than consumer prices — has plummeted from 1.4pc to
0.4 over the last year.

This means that
China’s nominal GDP growth has dropped to just 7.4pc and is nearing the
levels of the post-Lehman trough. This is the indicator that matters for
the solvency of China’s heavily-indebted companies.

Mr
Edwards said the next shoe to drop in world the economy (leaving aside
the Donbass) is a systematic attempt by China to export its deflation to
any other sucker willing to accept it by driving down the yuan.

Those
countries that have failed to build adequate defences by keeping
inflation safely above 1pc could face a nasty shock when this happens.
The eurozone looks like the sucker of last resort. A Chinese
deflationary tide would push Southern Europe over the edge.

Perhaps that is why the ECB’s Mario Draghi sounded ever more alarmed today in his efforts to talk down the euro today.

I
take no view on how far China intends to go with this. It may reverse
course any time. I merely pass on SocGen’s view for readers to think
about.

Nor have I made up my mind whether
the yuan is correctly valued. Diana Choyleva from Lombard Street
Research says it is 15pc to 25pc overvalued as a result of surging wages
and poor productivity growth....